Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if SmartHeat (Nasdaq: HEAT) fits the bill.

The quest for perfection

When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at SmartHeat.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 99.6%* pass
  1-Year Revenue Growth > 12% 83.1% pass
Margins Gross Margin > 35% 35.2% pass
  Net Margin > 15% 17.4% pass
Balance Sheet Debt to Equity < 50% 5.1% pass
  Current Ratio > 1.3 5.11 pass
Opportunities Return on Equity > 15% 18.0% pass
Valuation Normalized P/E < 20 10.62 pass
Dividends Current Yield > 2% 0.0% fail
  5-Year Dividend Growth > 10% 0.0% fail
  Total Score   8 out of 10

Source: Capital IQ, a division of Standard and Poor's. *Annual revenue growth since December 2006. Total score = number of passes.

SmartHeat's score of 8 is amazingly strong for such a tiny company. But investors have pummeled the stock in the past year. Let's take a closer look at the business to see what's producing such strong financials -- and such strong investor distaste.

SmartHeat is a Chinese company that produces heat exchangers and related infrastructure to help capture and use energy more efficiently, reducing reliance on coal. Given the need for clean technology in pollution-ravaged China, the company's in the right place at the right time.

Thus far, the company has delivered some seriously strong results. In its most recent quarter, revenue rose 36% from the previous year, and earnings jumped 25%. But investors sent shares down sharply because of 2011 guidance that fell short of analyst expectations.

It's easy to draw comparisons with Chinese solar manufacturers JA Solar (Nasdaq: JASO), Suntech Power (NYSE: STP), and Solarfun Power (Nasdaq: SOLF), all of which have sported similarly explosive growth in recent years. What sets SmartHeat apart, though, is that it doesn't have the extensive list of publicly traded companies to compete against that solar companies have. With SmartHeat shares depressed, fears resulting from reduced guidance might well give you a great buying opportunity.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add SmartHeat to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Suntech Power is a Motley Fool Rule Breakers selection. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.